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The Euro Widened the Culture Gap

Josef Joffe is the editor of Die Zeit in Hamburg. He is a senior fellow at the Freeman-Spogli Institute for International Studies and the Abramowitz Fellow at the Hoover Institution, both at Stanford University.

September 12, 2011

Culture doesn’t matter, Karl Marx orated; it is the “substructure,” the economy, that determines how society arranges its way of life. The tottering euro proves this great thinker wrong once more. It's the culture, stupid! The PIIGS – Portugal, Ireland, Italy, Greece and Spain – should never have been admitted to Europe’s common currency.

In the euro's first decade, labor costs rose faster than productivity in Spain, Italy, France, Portugal, Ireland and Greece. In Germany that curve stayed flat.

What did dour, disciplined Germany have in common with extravagant, happy-go-lucky Italy whose national debt is 120 percent of G.D.P.? What about Greece, a country rife with corruption and cronyism, that spends more on privileged groups like public-sector unions than its shoddy tax collection system could possibly generate?

In the first decade of the euro, unit labor costs among all the PIIGS, France included, rose steeply whereas in Germany that curve stayed pretty flat. Wages that rise faster than productivity are a nice shorthand for the culture gap. On one side stand the Northern Protestants with low deficits and debts as well as modest wage increases. On the other side are the “Club Med” members with short working weeks, early retirement, rigid labor markets, expanding state sectors and sheltered markets.

The ultimate irony is that the euro actually deepened the divide. The common currency suddenly allowed the profligates to borrow at lower rates than in the days of the shrinking drachma and lira. Why save if you can borrow? At the same time, the euro closed the escape route of devaluation, no longer allowing Italy et al to devalue just a bit faster than they inflated in order to stay competitive.

So the rest of Europe keeps dumping billions into the Aegean to save Greece. But default is just around the corner. The bigger issue is whether cultures can change. Naturally, when economies like the Greek one are contracting at a 5 percent annual rate, reforms are politically even more difficult. Just look at the unrest in Greece, Spain and Italy. But there is also growing domestic opposition in Germany against footing the bill sine die.

There are only two logical outcomes. One: Europe becomes like the United States -- a transfer and fiscal union where Massachusetts supports Mississippi in so many ways. These are known as “automatic stabilizers”: Social Security, federal unemployment benefits, Medicaid, etc. Two: The euro breaks up, leaving a “deutschemark zone” with the Netherlands, Finland, Austria and the Baltics as formal members, and Switzerland as well as the other Scandinavians as informal ones that peg their currencies to the neo-euro.

Alas, this is not how politics works. Europe will neither jump into full political union, nor fall back into renationalizing its money in line with national cultures. So what next? The answer is easy. Greece will default and lenders will take a haircut of at least 50 percent. For Greece, the debt burden will shrink accordingly while the rest of Europe will recapitalize national banks that have been hit hardest.

And then? Watch the bond markets as they turn on Italy, Portugal, Ireland and Spain. These countries should never have been in the monetary union, and now the bills have come due. This isn’t going to be pretty, but the British and the Americans have no reason for gloating. They are just as unhappy, but in different ways, as that famous first sentence in Tolstoy’s "Anna Karenina" has it.